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2023 C2 H2 Economics

Additional Revision Lectures

Firms and Decisions


MI 2022 Prelim Q3

China has joined Europe and the US in curbing the power of big technology companies. China has
increased scrutiny on the technology sector and introduced a slew of new regulations that have tried
to rein in the power of its domestic giants like Alibaba Group Holding Ltd and Tencent Holdings Ltd.

Source: CNBC, 17 May 2021

(a) Explain the market structure that the technology companies are in and how it will affect their pricing
and output decisions. [10]

(b) Discuss the extent to which consumers and the government will benefit when there is greater
competition in the technology industry in China. [15]

Part (a)

Introduction

Market structure categories firms based on level of competition in their respective markets. The degree
of competition in the market can be gauged from the barriers to entry, size and number of firms and
presence of market dominance. Here we shall analyse the likes of Alibaba and Tencent as the big
technology (tech) firms.

R1: Explain the characteristics of big tech firms and how they fit into the oligopolistic market structure

Barriers to entry

The big tech firms like Alibaba, operate in a market that is imperfect as consumers do not have perfect
knowledge of all the services provided by them. There are barriers to entry for new entrants as the big
technology firms require substantial start‐up investments in technological infrastructure (eg high costs of
internet‐related airwave applications, huge network distribution platforms etc). The high fixed costs
involved and the costs associated to the running of the business can be a major consideration for any
potential entrant intending to enter the market.

There are also intellectual property rights that new technology firms need to observe and comply, hence
potential firms may find it challenging to enter the industry.

Number and size of the firms and market dominance

There are only a few big and well known tech firms in the market and hence the market shares of these
few top firms, as measured by the concentration ratio, is likely to be high. The firms being large, would be
able to reap substantial internal economies of scale, and enjoy low unit cost of production. All these
features will imply that the big firms have high market power and would be dominating the market.

Mutually interdependence of firms

As there are only a few dominant firms in the industry, they are mutually interdependent. This is seen
when a firm makes a decision, it has to consider the reactions of the other firms in the industry. Likewise,
each firm will be affected by its rival firms’ actions.
2023 C2 H2 Economics
Additional Revision Lectures

The big tech firms belong to the oligopolistic market structure due to: high levels of barriers to entry, only
a few big firms in the market, and they are seen to have market dominance and where they are also
mutually interdependent.

R2: Explain how the oligopolistic market structure would influence the firms’ pricing and output.

Even though the big tech firms are mutually interdependent, they can either collude or compete with
their rivals. If the firms cooperate like in a cartel arrangement, they now behave like a monopoly where
they would jointly maximise profits.

The colluded firm would produce at the output where its Marginal Cost matches its Marginal revenue. It
will then price its product along the demand curve facing the firm (or its AR line).

In Figure 1, the firm would choose to maximise profits by producing where MR=MC, producing at Qe and
pricing at Pe.

The salient feature of the oligopolistic market is that even if the firms decide to compete with their close
rivals, they also display rival conscious behaviour, where a firm takes actions and also look out for
reactions of their rivals. Each firm recognises that their rivals will notice any action it takes. For example,
when one firm offers to lower prices for its product, rival firms could counter offer immediately. Hence
in this situation, firms are unlikely to benefit from lowering prices, and hence may decide against changing
prices to compete and this leads to a tendency for the prevailing market price of product to remain
relatively stable. On the other hand, when a firm raises its price, its competitors will not follow and hence,
the advantage of lowering prices to attract competitors’ consumers might not materialise. Under such
circumstances, price competitions might seem futile and so these big firms may use non‐price competition
such as improvement of quality, product design, packaging or advertising to increase the demand for their
product and hence output will vary according to demand.

Conclusion

The big tech firms belong to the oligopolistic market structure and firms in this market exhibit mutual
interdependence behaviour. These firms use the profit maximising method for pricing and the amount of
2023 C2 H2 Economics
Additional Revision Lectures

output produced is at where MC matches MR. Oligopolistic firms may collude and compete with their
rivals, and even when they compete, they seldom use price competition and thus market price tends to
remain stable. However, non‐price strategies are often used to boost demand for their products and
hence the output produced will vary according to the demand.

Marking Scheme

Level Descriptors Marks

L3 ● Breadth & Application 8‐10


o R1: Explain the relevant characteristics of oligopoly market structure as big
tech firms are likely to belong to this category.
o R2: Explain how prices and output are determined when firms follow the
profit maximising goal.
o Moreover, answer has taken note of collusion or competition of oligopolistic
firms and how such firms usually do not vary prices but use non‐price
competition due to strong mutual interdependence.

● Depth
o Applies relevant economic concepts or theories
o Explains with rigour and detail
o Explains and illustrates with relevant diagram(s) and example(s)

L2 ● Lacking in any one of the L3 criterions 5‐7

L1 ● Largely irrelevant response 1‐4


● Descriptive response with non‐existent or minimal or application of economic
concepts or theories
● Serious and pervasive conceptual errors

(b) Discuss the extent to which consumers and the government will benefit when there is greater
competition in the technology industry in China. [15]

Introduction

The impacts from greater competition in the technology market and whether these will benefit consumers
and the government shall be analysed and discussed in terms of prices that consumers pay, the quality,
variety and choices available for them; and for the government, it is the achievement of greater allocative
efficiency in the economy.

R1: Analyse and explain how more competition benefits consumers.

Prices fall with more competition


Greater competition in the tech market means that more firms have entered the market, and with more
competition, this could lead to lower prices for consumers as there are now more substitutes in the
market. Thus the demand facing each firm will fall as shown in Figure 2.
2023 C2 H2 Economics
Additional Revision Lectures

Figure 2: More firms entering the tech market

From Figure 2, with more competition, the demand curve facing each firm in the industry falls and
becomes more price elastic in demand as shown by AR shifts from AR1 to AR2. The equilibrium output is
obtained from MR=MC and the price charged is from the demand curve AR. Lower price is charged at P2
compared to initial P1. Consumers benefit from a lower price.

With possible smaller profits, firms would cut wasteful spending. Before the increased competition, due
to the high barriers to entry the tech firms may have lax cost controls such as overstaffing and excessive
spending on unnecessary equipment and expensive buildings. They may be producing above the LRAC
and hence are X‐inefficient. However, with more competition, firms are less X‐inefficient and this benefits
the consumers when cost savings are passed on to them in the form of lower prices.

More competition could also lead to better quality of products for consumers and hence higher consumer
satisfaction. This is because firms will engage in non‐price competition, such as improving quality of goods
such as providing more innovative applications to compete for market share now that there are more
competitors.

More choices are available with entry of more competitors into the market. Consumers are not
constrained to buy from the few big firms. With the entry of other firms, consumers have the option to
choose and need not just buy from, say, the Alibaba e‐commerce platform.

Ev1: Greater competition may not benefit consumers


The tech market in China comprises big tech firms which operate on large scale production and hence is
able to reap internal economies of scale. However, with greater competition, the market is now shared
with more firms, each of which would have a smaller share of the market. The smaller scale of production
means that the firms may not be able to reap internal economies of scale (cost savings). Hence the newer
firms may produce at a higher cost of production than the initial large tech firms. This may result in higher
prices of goods as internal economies of scale are not reaped.
2023 C2 H2 Economics
Additional Revision Lectures

In the area of innovation and R&D, with more regulations on the tech firms, this may prove to be a
disincentive for firms to engage in product development or to carry out process innovations that are
beneficial for the firms. However, the extent of innovation would depend on the contestability of the
market after government’s regulations.

R2: Analyse and explain how more competition benefits the government with greater allocative
efficiency in the economy.
When there is greater competition in an oligopolistic market structure, there will be a fall in allocative
inefficiency. Allocative efficiency is achieved when the value that consumers place on the good equals to
the marginal cost of production, ie, P=MC. As oligopolistic firms are few and each has a relatively steep
downward sloping demand curve, it will never be able to be allocative efficient. However, with more firms
entering the competition, the demand curve becomes more price elastic in demand, the gap between
Price and MC would be narrower and hence there is improvement in allocative efficiency.

Ev2: Other types of inefficiency might arise to the detriment of the government.
Although allocative inefficiency could be reduced, there is another type of inefficiency which might be
worsened. Increasing competition may mean that dynamic efficiency may have to be forgone. Dynamic
efficiency is affected by whether firms have the ability and incentive to conduct R&D to develop and
innovate products and or process, leading to better products and making use of resources more
efficiently.

Increasing competition may lead to more but smaller firms which would not be able to earn as much
supernormal profits in the long run, as the oligopolists. This would limit the amount of funds each firm
has to engage in R&D.

This inability in funding development or innovation of products and production processes can be seen as
a setback for the government in its drive for more efficient resource allocation.

R3: Explain how more competition can benefit the government in its attainment of the macroeconomic
goals of economic growth and balance of trade [R3 is an alternative point, not necessary if R1 and R2
are already well explained].

If better products and lower prices are achieved as a result of increased competition, then more
products/services will be produced or more worldwide subscribers are attracted to the better
technological platforms. These could boost China’s exports and improve its BOT, resulting in higher
economic growth, which are also the goals of the government.

Ev3: As only the tech sector is said to have experienced more competition, to achieve economic growth
and improved BOT, which are macro goals, these could happen only when there are no other events that
would negate these achievements, ie, under the ceteris paribus assumption.

Summative conclusion:

In general, whether increasing competition is likely to be beneficial or costly to consumers and the
government depends on whether better products and lower prices resulting from a more cost efficient
use of resources depends on the nature of the industry and the context of the market the firms are
2023 C2 H2 Economics
Additional Revision Lectures

operating in. For technology firms, technology becomes obsolete very quickly. Increasing competition is
not likely to threaten the performance of the big technology firms due to their current market share. They
are more likely to engage in R&D to maintain their market share due to increased competition. In their
line of business, it is even more important to have a better understanding of customer insights and strictly
execute these strategies throughout the innovation cycle. Moreover, increasing competition is therefore
likely to be beneficial to consumers and improve resource allocation which most governments pay much
attention to.

Marking Scheme

Leve Descriptors Marks


l

L3 ● Breadth & Application 8‐10


R1: An analysis of how increasing competition to the technology industry could
be beneficial to consumers in terms of lower prices due to cut in X‐inefficiency
and presence of non‐price competition.
R2: An analysis of how increasing competition could bring about improved
allocative efficiency for society.

● Depth
o Applies relevant economic concepts or theories
o Explains with rigour and detail
o Explains and illustrates with relevant diagram(s) and example(s)

L2 ● Lacking in any one of the L3 criterions 5‐7

L1 ● Largely irrelevant response 1‐4


● Descriptive response with non‐existent or minimal or application of economic
concepts or theories
● Serious and pervasive conceptual errors

Evaluation

E3 ● Well‐explained evaluative judgement about BOTH requirements with an overall 5


summative conclusion leading to a well‐explained evaluative judgement.
● The overall stand was justified by the inclusion of additional concluding points to sway
the overall argument.

E2 ● Takes a clear overall stand which is only partially justified as 3‐4


● Only some of the points mentioned in the body were evaluated
● The arguments used to evaluate individuals points were unconvincing or
somewhat flawed
2023 C2 H2 Economics
Additional Revision Lectures

● Provides insightful opinion(s) which are however not directly relevant to the
requirements of the question
● A ‘learned’ evaluative statement for one of the requirements

E1 ● Provides unsubstantiated opinion(s) 1‐2


● A ‘learned’ evaluative statement for both requirements.

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